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Can stock market liquidity and volatility predict business cycles?

Benjamin Carlston (Eberhardt School of Business, University of the Pacific, Stockton, California, USA)

Studies in Economics and Finance

ISSN: 1086-7376

Article publication date: 5 March 2018

431

Abstract

Purpose

The purpose of this paper is to predict real gross domestic product (GDP) growth and business cycles by using information from both liquidity and volatility measures.

Design/methodology/approach

The paper estimates liquidity and volatility measures from over 5,000 NYSE rms and extracts a common factor, which the paper calls uncertainty. In-sample and out-of-sample forecasting tests are used to determine the ability of the uncertainty factor to predict growth in real GDP, industrial production, consumer price index, real consumption and changes in real investment.

Findings

The paper finds that on average, positive shocks to the uncertainty factor occur in the quarters preceding and at the beginning of a recession. During the quarters toward the end of recessions, there are negative shocks to uncertainty on average.

Originality/value

Previous research has explored using either liquidity or volatility to forecast economic activity. The paper bridges the two branches of research and finds a link to real GDP growth and business cycles.

Keywords

Acknowledgements

I would like to thank the two anonymous referees for their suggestions and comments.

Citation

Carlston, B. (2018), "Can stock market liquidity and volatility predict business cycles?", Studies in Economics and Finance, Vol. 35 No. 1, pp. 81-96. https://doi.org/10.1108/SEF-05-2016-0131

Publisher

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Emerald Publishing Limited

Copyright © 2018, Emerald Publishing Limited

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